After missing relatively small bond payments last August and this January, Puerto Rico's public sector defaulted on at least $367 million of principal due May 1. As a consolation, investors did receive $9 million in interest from the defaulting entity, Puerto Rico's Government Development Bank.

The fact that Puerto Rico even has a Government Development Bank should raise an eyebrow. State-owned banks are not a major feature of the mainland US economy, perhaps because failures of state banks contributed to a number of state bond defaults in the 1840s. Since the US didn't take over Puerto Rico until 1898, the island was not around to learn that lesson. The GDB is one of over fifty public corporations dominating Puerto Rico's economy. Others control the island's electricity, water, and sewer services.

Public corporations date back to the 1940s and largely owe their existence to the efforts of Rexford Tugwell. "Red Rex" was a Columbia University economist who was sold on the virtues of the Soviet way when he visited Stalin's Russia in 1927. He went on to play a leading role in implementing Roosevelt's New Deal. In 1941, FDR appointed Tugwell as Puerto Rico's governor, where he applied a similar state-led economic model. While much of the New Deal was unwound on the mainland, Puerto Rico's public corporations persisted on the strength of borrowed funds.

Puerto Rico's 1917 congressionally-imposed constitution limited Puerto Rico's central government and municipal debt to 7 percent of assessed property values. It also mandated a balanced budget. These limits did not apply to public corporation debt, and these entities started borrowing liberally.

A new constitution ratified in 1952 as amended in 1961 relaxed constitutional limits on Puerto Rico central government and municipal borrowing. A major cause of this relaxation was a mistranslation of balanced budget language in the 1952 constitution. While the English version instructs the legislature to balance revenues and expenditures, the Spanish translation of revenues was closer to "resources". The Puerto Rico government interpreted "resources" broadly, even including bond proceeds. It thus became possible to "balance" the budget with borrowed funds.

By the early 1980s, public sector debt had reached 82 percent of GNP—not far below today's level of about 100 percent. Puerto Rico muddled along with high debt levels until recently, when a long-lasting recession, out-migration, a string of unbalanced budgets, and loss of bond market access triggered the current crisis.

.....
Now that Puerto Rico's crisis has deepened, House Republican leadership and the Obama Treasury Department have reached a broad agreement on what needs to be done. The plan, embodied in HR 4900, combines a new legal process for debt restructuring with a federal oversight board to help Puerto Rico balance its budget.

Oversight boards are undemocratic, but they succeeded in New York and Washington, DC. As I discussed in a recent paper for the Mercatus Center at George Mason University focusing on the historical causes and potential solutions for the crisis, this formula also proved effective in Newfoundland—which was transformed from an insolvent British Colony to a debt-free province of Canada by an appointed government.

On Friday evening, House Speaker Paul Ryan said legislation to restructure Puerto Rico’s ailing finances will be introduced in the coming days.

“Right now, we are working with the Natural Resources committee, the administration, and our Democratic counterparts to iron out the final constitutional and legal questions surrounding the legislation,” Ryan said in the statement. “Let me be clear: There will be no taxpayer bailout of Puerto Rico.”

The measure seemingly hit another snag this week when House Natural Resources Committee Chairman Rob Bishop (R-Utah) delayed the introduction of an expected reworked measure to deal with some technical issues.

Earlier Friday, Treasury Secretary Jack Lew said the House's delay shouldn’t be misinterpreted as a lack of progress.

Lew said that while time is of the essence, with a looming $2 billion debt payment due on July 1, Treasury and Congress are making progress toward a long-term solution to the island’s fiscal woes.

“The substance is more important than the schedule, as long as it gets done for Puerto Rico,” Lew told reporters at a Christian Science Monitor breakfast in Washington.

“So I wouldn’t confuse delaying a day with a lack of progress; sometimes a delay can be a sign of progress if you’re getting close to something,” he added.

House Republicans and Democrats reached a rare, election-year deal with the White House to try to rescue Puerto Rico from $70 billion in debt as millions of Americans in the cash-strapped U.S. territory struggle with the loss of basic services.

A revised House bill introduced late Wednesday would create a board to help manage the territory's financial obligations and restructure some debt. Negotiations between the Obama administration and House Speaker Paul Ryan's office helped finalize the legislation.

It is a "fair, but tough bipartisan compromise," Treasury Secretary Jack Lew said.

Ryan, R-Wis., said the legislation would avoid an eventual taxpayer bailout.

Puerto Rico, mired in a decade-long recession, already has missed several payments to creditors. A $2 billion installment, the largest yet, is due July 1.

......
Like U.S. states, Puerto Rico cannot declare bankruptcy. The legislation would allow the control board to oversee negotiations with creditors and the courts over reducing some debt.

The compromise "achieved a restructuring process that can work," House Democratic leader Nancy Pelosi said.

A vote could happen next week in the Natural Resources Committee. The panel's chairman, Rep. Rob Bishop of Utah, had to cancel a vote last month amid objections from both parties.

Since then, Bishop and Ryan have worked to win over conservatives who worry the rescue might set a precedent for financially ailing states. Democrats, too, had to be persuaded the control board wouldn't be too powerful and debt restructuring too difficult.

.....
In a nod to Democrats, the final bill also removes a provision that would have transferred federal land on the nearby island of Vieques to Puerto Rico's government. But Puerto Rico would be allowed to temporarily lower federal minimum wage requirements for some workers, which Democrats have opposed.

Still, Puerto Rican Gov. Alejandro Garcia Padilla said the bill still isn't "consistent with our country's basic democratic principles." He wants a less powerful board that can't fully control the island's finances.

Under the legislation, the control board would require Puerto Rico to create a fiscal plan. That includes directing the territory to provide adequate funds for public pensions, which the government has underfunded by more than $40 billion.

.....
The agreement to restructure the island’s $70 billion in debt fulfills a promise the Speaker made to Minority Leader Nancy Pelosi (D-Calif.) and Democrats during spending talks last December. And it shows that Ryan’s approach to the leadership job — empowering committee chairmen — can work, to a certain extent.

For months, Ryan deferred questions about Puerto Rico to Natural Resources Committee Chairman Rob Bishop, letting the Utah Republican spearhead talks with both Democrats and Republicans on his panel. But when negotiations got bogged down by a few sticking points, including the creation of an independent fiscal control board, Ryan stepped in to close the deal.

Ryan spoke with White House chief of staff Denis McDonough last week as the accord neared the finish line. One recent weekend, Ryan spoke by phone with Treasury Secretary Jack Lew while mowing his lawn at his home in Janesville, Wis., according to sources familiar with the discussions. Ryan and Lew, two policy wonks, had crossed paths in 2011, when Ryan was the chairman of the Budget Committee and Lew the White House’s top budget official.

.....
The Puerto Rico legislation still hasn’t been scheduled on the House floor. Bishop will mark up the bill in his committee on Wednesday, leaving the full chamber just one day to take it up before lawmakers leave town Thursday for the Memorial Day recess.

Some lawmakers want a quick vote on Puerto Rico this week. The longer it hangs out there, the thinking goes, the more time political foes will have to try to stir up opposition. On the left, Sen. Bernie Sanders (I-Vt.), a Democratic presidential candidate, urged his Senate colleagues Monday to oppose the legislation, ripping the oversight board as “undemocratic” because it’s comprised of “unelected” appointees.

One option would be passing the House bill on suspension, which requires a two-thirds majority. It wouldn’t be impossible given Ryan’s prediction that a majority of House Republicans will support the legislation; most Democrats have signaled they’re on board as well. Language affecting Puerto Rico’s minimum wage and keeping a wildlife reserve in federal hands helped cement Democratic support.

But GOP leadership sources said a floor vote isn’t expected until after the weeklong break. Lawmakers want to act before July 1, when the cash-strapped territory is at risk of defaulting on another $2 billion in payments.

.....
The bill offers debt relief to Puerto Rico in return for a mechanism to overrule the territory’s feckless current government and impose reform. The legislation explicitly pre-empts conflicting laws and regulations passed by the commonwealth. It also stipulates that legal challenges will be heard in federal rather than commonwealth court.

The key to the reform is a seven-person control board modeled after the board that pulled the District of Columbia out of a debt spiral in the 1990s. The President would select the board from nominations by the House Speaker (two), Senate Majority Leader (two), House Minority Leader (one) and Senate Minority Leader (one). The President has sole discretion to choose the seventh. The appointments must be made by Dec. 1, and the terms last three years, so the GOP majority’s choices will steer the board’s crucial early decisions.

The board can subpoena documents, conduct audits, hold hearings, veto overspending and impose reforms to, say, pensions, taxes and worker pay. It can compel the Puerto Rican government to privatize assets. Most importantly, the board can override laws, regulations, contracts and executive orders that conflict with its fiscal plans.

Creditors and the commonwealth’s 18 debt issuers would be encouraged to cut deals with terms that could be more favorable to both parties than those that might later be imposed by a judge. But the legislation also includes a collective-action mechanism that would allow two-thirds of the principal amount of each creditor pool to bind holdouts. If voluntary negotiations fail, a supermajority of the control board could authorize a federal court-supervised restructuring similar to Chapter 11 bankruptcy.

This process would extend the nine-month automatic stay on litigation imposed by the legislation. After ensuring that financial audits and a fiscal plan have been completed, the board would propose a plan of adjustment that is fair and equitable. The legislation explicitly requires that the plan respect creditor priorities and liens and be “in the best interest of creditors.” So if Democrats later control the board, they couldn’t subordinate general obligation bondholders to pensioners.

Pensions are Puerto Rico’s single biggest liability at $46 billion. In recent years the commonwealth has raised the retirement age, increased worker contributions and shifted employees to hybrid plans similar to cash-balance accounts. But because the pension funds are nearly broke, the control board will have to further modify benefits. The legislation also requires that the fiscal plans “provide adequate funding for public pension systems,” so Puerto Rico can’t short pensions as it has in the past.

The board would remain in effect until Puerto Rico’s government has access to short- and long-term credit markets and has produced four consecutive balanced budgets. We’d prefer a longer time horizon that would keep the board in abeyance similar to New York’s financial control board if the commonwealth returns to perdition. But Washington will need Puerto Rican support to implement reforms, and promising to return complete control will encourage cooperation.

At the heart of the House Committee on Natural Resources’ Puerto Rican Bill, introduced by Representatives Sean Duffy (R-WI), Rob Bishop (R-UT), and Jim Sensenbrenner (R-WI), is the establishment of a seven-member oversight board for the island. That board is to have exclusive control to ensure that Puerto Rico’s fiscal plans are enacted and enforced as well as to ensure that necessary reforms are undertaken to help the island regain fiscal solvency. The bill also includes a stay on debt-related litigation to create an environment for consensual negotiations with creditors. It is explicit that it will not involve taxpayer money to bail out the island.

Beyond not involving a taxpayer-financed bailout for Puerto Rico, there would seem to be main two strengths to the current bill. The first is that it would ensure very much better fiscal management than the island has experienced in recent years. It would do so by subjecting the island to the effective management of an outside technocratic control board that would among other things demand greater fiscal transparency, greater spending efficiency, and better fiscal accounting from the island than it has had in many years.

The second main strength is that it would afford the island with a temporary stay on debt principal repayments to allow more time for the voluntary restructuring of its debt mountain. That stay would forestall an otherwise disorderly Puerto Rican default as early as July 1, when some $2 billion in debt repayments come due. This must be welcomed since a legal free-for-all that would almost certainly follow a full-scale default would adversely affect an economy already in the deepest of slumps.

The main weakness of the bill is that it offers very little in the way of measures to turn Puerto Rico’s dismal economic fortunes around. To be sure, it does envisage that the oversight board will insist on regulatory reform and that it will secure a reduction in the minimum wage for those Puerto Rican workers between 20 to 25 years of age. However, it would be fanciful to think that limited measures of that sort are going to provide the Puerto Rican economy with the major shot in the arm that it desperately needs to begin growing again.

.....
David Skeel: On the question of how we got here, as is always the case, it’s overdetermined. Lots of different things happened to send Puerto Rico into a tailspin. One of the things that happened was Puerto Rico had a big tax break for manufacturers who came to Puerto Rico. Pharmaceutical companies in particular took advantage of that. That tax break was phased out starting in the late 1990s, and finally phased out, I believe, in 2006, and a lot of that industry left. So that was one of the problems. They’ve had employment problems generally. They ended up, over the last 10 years or so, funding government operations with debt. There are some other factors as well, but those are some of the big pieces of their problem.

Knowledge@Wharton: One question that has been brought up is whether or not — even though Puerto Rico is a territory — it should have the ability to file for Chapter 9 bankruptcy. What’s your opinion?

Skeel: Well, I think they should. Many people think they should. Not everybody thinks they should. As most people who are listening will know, Chapter 9 allows municipalities in states that permit Chapter 9 to file for bankruptcy. Puerto Rico was excluded from this in 1984. So Puerto Rico’s municipalities cannot file for bankruptcy.

In my view, Puerto Rico and its municipalities ought to be able to file for bankruptcy. But there’s lots of opposition to that. Some people would be OK with Chapter 9 for Puerto Rico’s municipalities, but not for Puerto Rico itself. Some people don’t want either, some people want both.

Knowledge@Wharton: Is it just the fact that it’s a territory that is really holding back the government from designating Chapter 9 as a possibility for Puerto Rico?

Skeel: Historically, yes. If Puerto Rico was a state, or had become a state, there’d be no question about the ability of its municipalities to file for bankruptcy. Now, there would be a question whether that’s enough. A large share of Puerto Rico’s debt is either directly or indirectly owed by the territory itself. So some people — including me — think that Puerto Rico needs to be able to file for bankruptcy. But putting that to one side, it’s clear that the island’s municipalities would be able to file for bankruptcy if Puerto Rico was a state. But this is something that it lost out on, because it’s not.

......
Knowledge@Wharton: And the value of those bonds, each and every day that this process is going on, is …?

Skeel: It’s dropping. And in fact, even the most well secured bonds — Puerto Rico issued a lot of general obligation debt that is guaranteed by the Constitution — I think they’re selling at about 70 cents on the dollar right now. And those were thought to be bulletproof. And it goes down from there.

Knowledge@Wharton: What is the expectation of Wall Street in all of this? Because these bonds are losing a lot of value.

Skeel: Wall Street expects that the bondholders are not going to get 100 cents on the dollar. And that’s why they’re trading, for even the secure ones, at 60 and 70 cents on the dollar.

......
Knowledge@Wharton: You also mentioned in an article you did for the Public Policy Initiative here, the unemployment problem in Puerto Rico right now. In the United States, economists view it as disappointing that the labor participation rate is in the low 60% range — it’s 62.5% right now. In Puerto Rico, it’s not even above 50% at this point, correct?

Skeel: Depressing is the only word that comes to mind to describe it. Yes, it’s below 50%. And when you look at the statistics for young people, it’s even worse. It’s a complete mess. There are lots of proposals for what to do about that. One of the proposals that folks are talking about is making the minimum wage lower in Puerto Rico. Would that help with employment? But it’s a mess at this point.

SUMMARY:
• This Issue Brief summarizes events surrounding the current debt crisis in Puerto Rico and presents a two-step plan for restructuring Puerto Rico’s debt and encouraging more effective governance. This plan draws extensively on the previous experiences of debt crises in municipalities on the U.S. mainland.
• Step one entails the creation of a financial control board (FCB) for Puerto Rico, monitored by the U.S. federal government but involving significant Puerto Rican representation, which would terminate its active role in Puerto Rico’s affairs once fiscal benchmarks are established and satisfied. This FCB needs to have more authority than envisioned in the proposal by Senate Democrats, but less than that recommended in draft legislation from House Republicans.
• Step two would be for Congress either to craft a restructuring framework applicable to all of America’s territories, or to extend the existing bankruptcy laws in Chapter 9 of the Bankruptcy Code (with modifications) to Puerto Rico and its municipalities.
• Together, these two steps would remove the risk that Puerto Rico will pick and choose which obligations to pay and ensure that creditors’ priorities will be honored—all the while avoiding a true taxpayer-funded bailout. But Congress must act quickly.

Three and a half million Americans live on an island that is in economic free-fall, and Congress still isn’t sure whether it will throw them a lifeline. A bipartisan bill to help Puerto Rico is expected to come to a vote soon in the House. It has flaws and it is facing opposition on many fronts, but at this late hour it offers the island its best chance of survival.

This is how urgent the situation is: Thousands of residents leave for the mainland every month to seek jobs and better public services, and the exodus will accelerate if nothing is done to change Puerto Rico’s trajectory.

With its economy in decline for a decade, the island has accumulated huge debts that it cannot repay. It owes $72 billion to investors and about $46 billion to government pension funds. The island started missing bond payments in January and it is expected to default on a nearly $2 billion payment due on July 1, which will surely prompt creditors to file a wave of lawsuits seeking repayment.
.....
The legislation has other problems. One provision would exempt Puerto Rico from the Department of Labor’s recent decision to make more managerial workers eligible for overtime pay. Another would allow the island’s governor to temporarily set a minimum wage for workers younger than 25 that is less than the federal wage floor of $7.25 an hour. The good news is that it is hard to imagine that a governor would take advantage of this measure since it would only encourage more young people to move to the states, where they are assured a higher wage.

Though the bill has the support of prominent Republicans and Democrats in the House, it still faces opposition. Some bondholders object, saying the bill unfairly benefits pensioners at their expense. Well, creditors should have known they risked losing some of the money they put in Puerto Rican bonds given how indebted the island was. Many public employees and retirees in Puerto Rico have few sources of income besides their modest pensions. They cannot be left unprotected.

Some labor unions and Senator Bernie Sanders are also opposing the bill because of its labor provisions and because the financial control board would be able to override many decisions made by the island’s elected lawmakers. They are right on those two points, and perhaps Democrats can improve the bill. But time is running out for Puerto Rico. It needs all the yes votes it can get.

The report, shared with MarketWatch, states that some of Puerto Rico’s debt may have been issued illegally, allowing the government to potentially declare the bonds invalid and courts to then decide that creditors’ claims are unenforceable. The scope of the audit report, issued by the island’s Public Credit Comprehensive Audit Commission, covers the two most recent full-faith-and-credit debt issues of the commonwealth: Puerto Rico’s 2014 $3.5 billion general-obligation bond offering and a $900 million issuance in 2015 of Tax Refund Anticipation Notes to a syndicate of banks led by J.P Morgan
...

The Puerto Rican constitution contains a balanced-budget clause that explicitly prohibits borrowing to finance operating deficits, but its politicians borrowed to cover deficit financing in its 2014 General Obligation Bond Offering, according to the commission’s initial review. The March 2014 General Obligation Bond states that the proceeds would be used in part to cover deficits that had accumulated and that were expected to occur in the year of the offering. The documents include a chart showing deficits financed with borrowing during the past and that were expected to recur.

In addition, Puerto Rico did not inform bondholders that its constitution forbids it from using debt to finance deficits. That, the commission’s report says suggests “substantive” noncompliance with the letter of the constitution.

WASHINGTON (AP) -- The Supreme Court says Puerto Rico can't restructure the debt of its financially ailing public utilities to help overcome a decade-long economic crisis.

The 5-2 ruling Monday means the U.S. territory must wait for Congress to pass debt-relief legislation to help ease its fiscal woes.

The justices said federal bankruptcy law bars Puerto Rico from enacting its own law to restructure about $20 billion in debt.

Puerto Rico lawmakers passed the law in 2014 to help cash-strapped utilities meet obligations to bondholders and creditors. Puerto Rico argued that it could enact its own measures since the island is precluded from using bankruptcy law. But lower courts struck down the law.

The commonwealth is mired in recession and cannot pay $72 billion in public debt.